Gilts to test 0.1% in case of a hard Brexit, but yields could rise to 1% in case of a deal

Gilts to test 0.1% in case of a hard Brexit, but yields could rise to 1% in case of a deal by Michael McKenna
There is more upside for Gilts in case of a hard Brexit, but if a deal is agreed upon tonight, we might see yields rising to test their upper trendline at 0.45%. The BoE will be wary of 10-year yields rising above 1% even if a deal with the European Union has been reached.

There is nothing romantic about a candlelit dinner with Boris Johnson and Ursula von der Leyen; however, this time around it may be the trick that will bring a Brexit deal together. In the past few days, it was clarified by several politicians that a hard Brexit is very much possible, as much as a deal it is. At the time of writing, cable is moving up, ending a three-day run of losses, and Gilts are also softer. Yet, a move down of 8bps in yields since the start of the week it is a significant move given that 10-year Gilts offer around 27bps in yield. Even though tonight Santa may bring along a Brexit deal, it is essential to note that considerable obstacles continue to be ahead of the British economy. Therefore the effect of good news might wane quickly and bring the market back to reality.  As a matter of facts, the Covid-19 crisis inflicted deep scarring to the economy, which will take time to heal. The Bank of England knows it, and it is ready for more stimulus. Hence, only one outcome is possible: low Gilt yields for longer.

However, what does low mean in figure terms?

Since the beginning of August, we have witnessed to 10-year Gilt yields trading in an ascending channel. They have already tested the lower trendline three times, and if a hard Brexit comes around, they would most likely break it and move down to try the lowest yield ever recorded in history around 10bps.

At the same time, if tonight a Brexit deal is agreed upon we might see yields rising in the coming days and testing the upper resistance line at 45bps. However, we have to keep in mind that if a deal is reached, it doesn’t mean it will be a good deal for the British economy. Hence, an element of a surprise amid the reaching of an agreement can still give a boost to Gilts. Regardless, there is more room for yields to rise rather than fall to historic low levels.

In November, the BoE maintained the bank rate at 0.1% but announced an extra 150 billion pounds of asset purchases to be carried out until the end of 2021. The news boosted Gilts but didn’t manage to push yields down at such level to break the supporting trendline; hence the central bank failed to counter the rising in yields. Rising yields can be a problem for the British economy even if a Brexit deal has been forged for the simple reason that the economy is yet to recover from the Covid-19 pandemic shock. If yields rise, but the economic recovery lags, companies will see financing costs rising faster than revenues. Nevertheless, yields are currently so low that the BoE will most likely let them soar up to a certain level. I believe that the BoE’s tolerance level is around 1% in 10-year yields, which also corresponds to the level that yields will need to hit in order to break their decennial descending trend line.

In conclusion, in case of a hard Brexit, we will see 10-year Gilt yields falling to test the 0.1% benchmark bank rate level. In case of a favourable Brexit deal, we will see yields moving up to try their 45bps descending resistance line. In this scenario, yields can move up to 1%, but not higher because the BoE will be wary of having them rising faster than the economy recovers from the Covid-19 pandemic.

How to Trade Gilts on the Saxo Platform

You can buy gilts outright or purchase various instruments that will give you exposure to these securities such as:

  • Futures: FLGH1
  • ETFs: iShares Core UK Gilts (IGLT:xlon), Vanguard UK Gilt (VGOV:xlon), SPDR Bloomberg Barclays Gilt funds (GLTS:xlon, GLTL:xlon)
Topics: Bonds Government Bonds Brexit Central Banks European Union (EU)